The Spillover effects of Foreign Direct Investment (FDI) inflow on the productivity of domestic firms: A case of Ethiopian manufacturing firms

Many countries now strongly promote Foreign Direct Investment (FDI), through providing various incentive schemes and lowering barriers. Among the reasons for encouraging FDI inflows is the expectation of that they afford positive externalities (spillover effects) by transferring more productive technology to local firms and increasing competition. However, existing empirical studies provide mixed evidence - some conclude that FDI boosts the productivity of indigenous firms whereas others argue that the effect is either unclear or negative. Although studies have been conducted mainly in Asia, evidence concerning the impact of FDI in the African context is very scarce. Hence, in an effort to partially fill this gap, this study explores FDI spillover effects on the manufacturing sector of Ethiopia. For the purposes of this research, firm-level cross-sectional data for the manufacturing sector of Ethiopia was collected and analysed from the Central Statistical Agency (CSA) of Ethiopia for the year 2009 for over 1,000 firms. The results suggest that domestic firms benefit, in terms of both Total Factor Productivity (TFP) and Labour Productivity, from foreign presence operating in the same sector, defined at the ISIC four digit level. On the other hand, the result failed to confirm the existence of geographical component in the productivity spillover. The spatial result suggested there are agglomeration effects in Addis Ababa generating positive spillovers towards the indigenous firms, suggesting that nearby firms reap more of the benefits than do distant firms. There is some institutional evidence of co-operation between indigenous and foreign firms in the textile sector suggesting the existence of positive sectoral effect. To receive greater national gains from FDI presence appears to depend on encouraging more dispersion of FDI away from Addis as the primate city.